3.2.1 - Cash, profit and survival

Cash for operating payments

A business needs available money to make payments when they fall due. In business, cash includes money in a bank account that can be used to pay; it does not mean only notes and coins in a till.

Suppliers need payment for inventory and services. Employees need wages or salaries. Overheads are costs of running the business, such as rent, insurance and electricity, that are not directly traced to each individual product. These bills may have different due dates, but they all require a means of payment.

An illustrative Kenyan restaurant cannot pay its flour supplier with a claim that next month's bookings look good. It needs money by the agreed date. If it fails to pay, the supplier may stop deliveries. Without flour, the restaurant may lose sales and then receive even less cash. Late wages can damage employee trust and disrupt work; unpaid energy bills or rent can also threaten operations.

An illustrative large manufacturer faces the same issue with larger payrolls and suppliers across countries. Expected sales, valuable assets and a positive profit figure are useful, but none automatically settles a payment due today. The finance team must monitor the amount available and the dates of receipts and payments.

Cash versus profit

Profit measures the excess of revenue over the costs of earning that revenue for a period. Cash depends on when money is actually received and paid, so the two can move differently.

Revenue is income from sales. If goods are sold on credit, the revenue can be recognised when the sale occurs even though the customer pays later. The unpaid amount is a trade receivable: money owed by a customer. Likewise, a supplier's bill may relate to costs incurred now but be paid next month; that unpaid supplier amount is a trade payable.

In an illustrative April example, an Indian design studio earns INR 120,000 revenue and incurs INR 80,000 costs. Its profit for April is INR 40,000. However, it receives only INR 30,000 from those customers during April; the remaining INR 90,000 is due in May. If it pays all INR 80,000 costs in April, the month's cash receipts minus payments are negative INR 50,000. With just INR 20,000 cash at the beginning of April and no other receipts or funding, it cannot make all those payments on time. The sale can be profitable while the payment timing creates a shortage.